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The Biggest Threat To Dollar Dominance

Russian oil exporters are pressuring Western commodity traders to pay for Russian crude in euros and not dollars as Washington prepares more sanctions for the 2014 annexation of Crimea by Moscow, Reuters reported last week, citing as many as seven industry sources.

While it may have come as a surprise to the traders, who, Reuters said, were not too happy about it, the Russian companies’ move was to be expected as the Trump administration pursues a foreign policy where sanctions feature prominently. This approach, however, could undermine the dominance of the U.S. dollar as the global oil trade currency.

Early indications of this undermining became evident this spring, when Russia and Iran launched an oil-for-goods exchange program seeking to eliminate bilateral payments in U.S. dollars and plan to keep it going for five years. The sanction buddies discussed this sort of agreement earlier, back in 2014, when Iran was still under Western sanctions. Even after the notorious nuclear deal was reached, the two countries decided to go ahead with their barter deal, and the preliminary agreement was reached last year. According to it, Russia would receive 100,000 bpd of Iranian crude in exchange for US$45 billion worth of Russian goods.

In March, Iran banned purchase orders denominated in U.S. dollars and said that any merchant using dollars in their orders will not be allowed to conduct the import trade. A month later, Tehran announced that it will publish all its official financial reports in euros instead of dollars in a bid to encourage a switch to euros from dollars among state agencies and businesses.

Now, Russia’s biggest oil producers are renegotiating oil delivery contracts with commodity traders, and three of them, Rosneft, Gazprom Neft and Surgutneftegaz, have raised traders’ hackles by insisting they, the traders, commit to paying penalties beginning next year if U.S. sanctions disrupt sales and as a result the buyers fail to make payments. Also, there are discussions about using euros and other currencies instead of dollars to ensure payments are not disrupted.

It would make perfect sense for the seller of any commodity to ensure that they receive payment for their commodity. In an environment of sanctions, looking for ways around them is the only logical behavior. And Russia and Iran are not alone in this drive to distance themselves from the dollar. Related: Oil Prices Rise As Saudis Cut Exports

Venezuela, for one, has bet on digital currency as a way of skirting Washington sanctions that have added to the pressure created by the 2014 oil price crash and years of PDVSA mismanagement—both factors which have plunged the Venezuelan economy into a possibly irrecoverable crisis. Just today, crypto media reported that Caracas would present its cryptocurrency, the Petro, to OPEC as a unit of account for oil trading next year. “We will use Petro in OPEC as a solid and reliable currency to market our crude in the world,” Finance Minister Manuel Quevedo said.

China is also openly promoting its currency for oil trade and all trade. The internationalization of the yuan is part of the New Silk Road initiative of President Xi and given China’s level of oil consumption, oil trade is a big part of this internationalization. Earlier this year, China launched its long-awaited yuan-denominated oil futures contract. While the general trading public remains cautious about buying into it, some have forecast that the yuan will eventually replace the greenback as the global oil currency. And it could be joined by the euro as long as the European Union survives in the long term. After all, Russia and Iran are among the biggest oil exporters globally. That’s a lot of barrels that might be soon traded in euro and not dollars.

The biggest threat to the petrodollar is the petro-yuan. The launching of the petro-yuan on the 26thth of March 2018 will go in history as the most momentous day for the United States’ economy, China’s economy and the petrodollar and also for China’s status as an economic superpower.

In a paper titled:” Will the Petro-yuan be the Death Knell for the Petrodollar? published by the United States Association for Energy Economics on the 17th of April 2018 (paper reference 18-338), I argued that the launching of the crude oil benchmark on the Shanghai exchange could mark the beginning of the end of the petrodollar.

Right now, China is the number one exporter on the globe, the largest crude oil importer in the world and also the world’s biggest economy based on purchasing power parity (PPP). The Chinese would like to see global currency usage reflect this shift in global economic power.

The petrodollar system provides at least three immediate benefits to the United States. It increases global demand for US dollars. It also increases global demand for US debt securities and it gives the United States the ability to buy oil with a currency it can print at will. Maintaining the petrodollar is America’s primary goal. Everything else is secondary.

I have also argued that the imposition of tariffs on Chinese goods could be the first shots in the petro-yuan/petrodollar war of attrition. This could escalate into a trade war between the two countries and a possible wider conflict beyond. I concluded The that it is probable that the Chinese yuan will emerge as the world’s top reserve currency within the next decade with the petro-yuan dominating global oil trade backed by gold.

With major oil exporters finally having a viable way to circumvent the petrodollar system, the US economy could soon encounter severely troubled waters. First of all, the dollar’s value depends massively on its use as an oil trade medium. When that is diminished, we will likely see a strong and steady decline in the dollar’s value.

The petrodollar is backed by Treasuries, so it can help fuel US deficit spending. Take that away, and the US economy will be in trouble leading to a loss of value of the dollar against other currencies. Contrast this with a petro-yuan convertible to gold.

In less than seven months since its launch, the petro-yuan has already captured 32% of the global oil trade. How long will it take it to overtake the petrodollar as the oil currency?

Since the imposition of US sanctions against Russia in 2014 after the annexation of the Crimea, Putin has been working ceaselessly to undermine the petrodollar. He has been signing currency exchange agreements with China, Turkey, Iran, India and a host of other countries and also a barter trade agreement with Iran.

Now, Russia’s biggest oil producers are renegotiating oil delivery contracts with commodity traders demanding that they are paid in euros and other currencies instead of dollars. They are also demanding that traders commit to paying penalties beginning next year if U.S. sanctions disrupt sales and as a result the buyers fail to make payments.

The introduction of the petro-yuan is already undermining the petrodollar and nullifying US sanctions against Iran. The whole US sanction regime against Iran is at the mercy of China. China could singlehandedly nullify the sanctions on Iran by buying the entire Iranian oil exports amounting to 2.2 million barrels a day (mbd).

That is one reason among many why US sanctions on Iran are doomed to fail miserably.

The Author would be well advised to avoid partisan comments such as describing the Iran deal as notorious, and to take a more balanced approach.

From a European point of view the only thing notorious about it, is the way that the American President has shown that he is not to be trusted to honour the international commitments that his country has made.

His policy of weaponizing American financial strength through exploiting the position of the dollar as the world's reserve currency of choice carries risks and consequences which seem to be crystallising, and surely will lead to further destabilising of the World Economy.

The Author is right that this is a huge threat to the American Economy, and while the replacement of the Dollar by the Euro might have longer term benign consequences, that is not given, and would be disruptive in the short term.

Replacement of the Dollar by the Yuan, would be a much more sinister and worrying prospect.

Dan on November 13 2018 said:

I would think the ruble would be safer than the "Empire" EU.

Brian on November 18 2018 said:

The USA president does NOT have the power to make international agreements. The US Senate has that authority. So, NO, Obama opening his mouth does not mean anything regarding the IRAN deal. The USA is NOT a crappy horrid parliamentary system where minorities are screwed.

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